I'm not sure that "moral hazard" applies to individuals in the world of big business of high finance. But what allowing massively painful failures to occur does do is stiffen the political will to support regulation and oversight to prevent such messes from happening again. "We need to regulate to prevent economic disaster" is a much more compelling argument than "We need to regulate or else we'll just have another big bailout".

Mike

Moral hazard just departed with golden parachute intact.

Moral hazard implies that something the government does fails to hold those repsonsible accountable for their failure.

The CEOs get the big bucks whether they earn their keep or screw up big time like Carly Fiorina.

Avoiding moral hazard would mean tying CEO compensation more meaningfully to performance.

For the people making the decisions, it doesn't seem like the array of outcomes is that difficult to predict. Either they'll make many millions of dollars or they'll make many, many millions of dollars. If the company collapses, they'll move on to another company. Where exactly is the risk they'd be worrying about?

They're certainly not going to go hungry, or go to jail, or even have to pay back any of the money they made while causing the disaster. How can that not be a recipe for continued risky behavior in the future?

In the last sentence, "risky behavior" should perhaps be "disasters". The point is that it's not risky for those making the decisions, only for the rest of us.

The AIG loan isn't disrupting the threat of moral hazard, it's compounding it. (and moral hazard isn't a threat that moderates; rather, it amplifies)

The problem is that even when companies fold, the risk-takers usually still end up with millions of dollars in their personal accounts even if the shareholders get wiped out. I'm sure Dick Fuld is bummed and maybe his ego is bruised, but he's set for life.

In a sense, moral hazard problems are not affected by a company being bailed out or not since they never affect the individual. Does the coporation "Lehman Brothers" feel pain? No. The many employees who lost their jobs might, but a vast majority of them probably had zero influence on the risk-taking strategies.

The moral hazard problem is very real, and it won't be solved until CEO's have their own personal assets at stake.

Maybe if Robert Willumstad and Hank Greenberg were personally responsible for repaying AIG's huge debt, things would have been done differently. But, that is the whole point of a corporation. Legally, the company itself is the person who is responsible.

This wasn't always the case. owners used to be responsible for a company's debts (And still are in the case of partnerships and proprietorships). It was a law meant to help freed slaves that got bastardized that lead to this modern idea that the people who made millions upon millions could walk away unscathed while the company crash and burns.

I'm not saying we return to 19th century business practices, but I know a fair amount of people find it unjust that legally, the person responsible is not a person at all, but a stack of papers. At the end of the day, maybe we do need there to be a person of flesh and blood to take responsibility.

And then, on the other side, are you Bank of America, who was subject to regulatory oversight and didn't get caught with a heap of highly leveraged junk investments, and now sees their prudence repaid many times over because they're acquiring failed institutions for a song?

Bank of America paid twice market cap for Merrill. These are shotgun weddings; BA is not getting a good deal on them.

Shorter Kedrosky: Shut up whiners!

Taxpayers: But it's our money bailing out AIG.

Kedrosky: Exaggerator!

Ezra, doesn't this post contradict the one down below where you quoted with approval, "I have to imagine the employees of Bear Sterns and Lehman Brothers are currently thinking that they clearly did not take on enough risk over the past several years."

What is that but a reinforcement that the lessons of this whole mess is that you should take on more hazard, more risk? We're giving someone incentive to do something risky, which is what I understand "moral hazard" to me.

This is completely wrong on several levels.

First, the beneficiaries of the recent bailouts weren't receiving carried interest tax treatment so that's totally a red herring.

Second, the sort of moral hazard concerns that people are worried about are real and observable. Fannie Mae and Freddie Mac benefited from sharply lower borrowing costs for years because of the implicit promise of a bailout. Look at what happened to borrowing costs of other banks after the Bear Stearns bailout and before the Lehman bankruptcy filing. This isn't theoretical.

Moral hazard does not need make people change their behavior it just needs to move the money and power from the more risk taking crowd to more risk averse crowd.

E.g. certain people have been sitting on cash for a few years saying "these home prices are crazy" waiting to buy foreclosed properties at much lower prices.

Would rather have the risk taking CEOs hold the money and power of the more conservative?

This is fine as far as it goes, but it would all be easier to swallow if you didn't hear moral hazard arguments the second any Progressive legislation is proposed. We're supposed to shut up about moral hazard when it comes to AIG, but make it the guiding light of our thinking when it comes to, say, public housing or welfare.

I mean isn't the entire "cost-control" focus of conservative healthcare policy based on a specific species of moral hazard? Smoking and obesity regulation? It sure seems like we hear a lot about responsibility when the subject is NOT CEO's.

KCinDC wrote:
They're certainly not going to go hungry, or go to jail, or even have to pay back any of the money they made while causing the disaster. How can that not be a recipe for continued risky behavior in the future?

That is my problem with the corporate person.

IMO there are 2 problems that will insure periodic episodes like this:

1. Corporate person which shields responsible parties from the consequences of their actions.

2. Fractional Reserve banking which makes banking problems lead to contractions in money supply.

I think the point of these moral hazard arguments isn't that it's something we should avoid. The lesson to be learned is that their is always going to be some moral hazard. In which case rather then thinking the market will magically regulate it self, we the people have to setup in and regulate it through our government. Moral hazard is the counter argument to the freemarketers and advocates of de-regulation

Shorter version: There are always going to be bail outs, those bail outs will always create a moral hazard, so the government must regulate.

We're finding out that scale has consequences.

Lectures about moral hazard directed at poor people don't matter much; they don't spend much money. If a taxpayer funds end up supporting a "wayward" lifestyle, the expenditures will be too small to be significant for any single taxpayer.

With these large financial institutions moral hazard is a significant issue. Through negligent or criminal behavior, a few individuals can create a regulatory or business environment that requires significant expenditures by each individual taxpayer. Yet society is much less troubled by some guy getting tens of millions of dollars than by some guy buying a "Welfare Cadillac." Even if neither individual broke the law.

One can also consider the moral hazard that exists when legislative oversight of the executive branch is eliminated. The actions of a few individuals can burden significantly individual taxpayers.

Scale is important: it takes a lot of minnows to equal the mass of a single whale.

Yes, what FXKLM said, this is completely wrong on several levels.

By the way, Like AIG, with government ownership and an $85 billion loan that has to be paid back at credit card rates? Where can you get a credit card that charges an 11.3% rate?

As long as we're all being grown-ups about moral hazard, how about mustering some of that sober adulthood on behalf of struggling home owners facing foreclosure?

I can assure you, Main Street is about 1,000 times sicker than Wall Street of "Free Market" rhetoric being shoved in our faces.

It's not impossible to make an argument that the Fed is doing the best it can to reduce moral hazard by acting inconsistently. Behaviorists have long known that "random reinforcement" is best for longterm inculcation of conditioning. We'll have to see whether they let anyone else fail in the coming months.

And yeah, with none of the decisionmakers ending up in Sing Sing or waiting tables, the downside risk probably isn't enough to restrain anyone regardless of the corporate consequences.

Moral hazard works the same way in healthcare, not on the consumer side but on the hospital CEO side.

Billing Medicare is a license to steal money. Here's the steps to success:

1) Come up with a covert strategy to overbill Medicare

2) Medicare has too few regulators and fraud monitors to catch you for a few years.

3) Eventually Medicare gets lucky and stumbles onto the fact that Sacred Heart Hospital stole approx 100 million dollars over a 5 year period.

4) When the CEO finds out that the gig is up, he goes to CMS and begs and cries saying that if you make us pay all that money back the poor patients wont have a hospital to go to, because the cost of payign back those ill gotten gains will bankrupt the hospital

5) CMS falls for it hook, line and sinker. They require only that the hospital pay back 10% of their stealings. No jail time, no board shakeups, no nothing.

6) CEO goes back to the board and says "hey we just stole 100 million dollars from Medicare. They caught us, but all we have to do is pay back 10% of that and we're off the hook!"

7) Board celebrates and rejoices and gives their CEO a 200% raise for successfully stealing from Medicare with virtually zero consequences.

8) Next year, the CEO goes to the board and comes up with a plan to steal 500 million dollars on the next go-round.

9) Rinse and repeat

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